I cover entrepreneurs, people who create value (and make money) out of the ideas in their heads. I spent three years on staff at Forbes before leaving to start Haymaker , a PR firm for startups, in May 2014. (Don't worry, I never write about my clients.) In the age of "The Social Network" myth, I get a kick out of delving into the reality of launching a business. Before joining Forbes I spent a year toiling in startup obscurity at Squidjob.com. Since my bedroom was the office, I never had to sleep under my desk. Comments, tips and forceful criticism are appreciated.

Convertible debt has long served nobly as the default form of financing for early-stage startups. It’s legally simple, cheap and allows founders to avoid dilution until valuations and equity splits can be made on firmer ground. But according to Adeo Ressi, an eight-time entrepreneur who runs the startup mentoring program Founder Institute, there’s a dark underbelly to convertible debt that players on both sides of the table often fail to acknowledge or understand: namely, debt.

“Why are we weighing our companies down with debt?” Ressi asks. “As a founder it makes no sense.”

While founders and investors talk about convertible notes as if they’re nothing more than equity investments, in legal and accounting terms they’re debt until converting to equity at a new round of funding. As long as a company continues to grow and attract investor attention, this isn’t necessarily a problem. But as the ratio of angel investments to series A rounds shrinks and first-time angels flood deals with ‘dumb money’, Ressi sees the ballooning of debt as a looming crisis.

The problem is that once a conversion period rolls around, investors have the opportunity to actually call for the debt, potentially bankrupting companies or forcing them into debilitating negotiations. While this isn’t traditionally a problem in tight-knit Silicon Valley circles, first-time investors may be more prone to go against tradition and enforce their legal rights. With Ressi predicting this fall to be the “single biggest funding season in the history of startups,” he’s on a mission to save as many companies as possible from this ignominious fate.

“It’s one thing dealing with a former GoogleGoogle employee from Cupertino,” says Yokum Taku, a lawyer for Wilson Sonsini GoodrichGoodrich & Rosati who helped Ressi develop the new funding. “But an angel from Chicago or Atlanta who doesn’t know the rules of the game? That can be somewhat worrying.”

In response, Ressi and Taku have aligned legal reality with founder perceptions by creating what they call ”convertible equity” (sample term sheet below). Simply put, it’s convertible debt without the debt. Everything works more or less the same as in a convertible debt deal – investors get a discount for purchased shares that’s realized upon conversion at a capped (or uncapped) valuation – with the more onerous provisions left out. Investors don’t get the ‘gun’, as Ressi calls it, and companies don’t artificially carry debt on their books, a potential liability when seeking a line of credit from a supplier or closing a deal with a large corporation.

Though some doubt the extent of the problem that Ressi foresees – Taku mentioned that Paul Graham is particularly skeptical – this new financing arrangement seems an obvious improvement over the tangles of convertible debt. As Taku says, “There’s really no reason why this shouldn’t catch on.”

In addition to the above mentioned benefits, founders avoid complex interest-rate arrangements that come with convertible debt. And because angel investors are essentially loaning money to companies under current practice, many are breaking state laws which require them to be licensed lenders. Convertible equity deals will help angels stay legal. The new financing may also help angels realize some tax benefits through capital gains discounts for Qualified Small Business investments.

Always the entrepreneur, Ressi is optimistic about adoption: “I think that by the end of the year you’ll see 25% of angel deals move to convertible equity.” Those that may not, he says, are deals in asset-heavy businesses where investors who qualify as debtors have more to liquidate in the event of bankruptcy. He says that a top-four accounting firm, who declined to be named, has already given the go-ahead on the new financing.

For Taku the path forward is simple. “All it takes is one major player to adopt it.”

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Okay, so now as management I am less accountable and if I am an investor I have no leverage!? How is this good for the business?

The primary argument seems to be (paraphrased) – “If you are not from the valley and you don’t know how the games works we don’t want you coming in here and calling the debt, since you don’t really know how the game is played.”

Call me crazy but part of managements job is to deal with investors who may be electing to call their debt because they are not happy with the results produced? Further, I have found that is usually the “non-valley” investor asking the very good questions about performance more focused on the project at hand and not his or her status and politics with the other valley VC/Angles in the deal.

Thanks for this great post Adeo. One of the benefits investors have with convertible debt is that they rank above ordinary shareholders in a liquidation event. I presume this is not the case with convertible equity?